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Brian J Bushee

Transcrição

Hello, I'm Professor Brian Bushee, welcome back. In this video, we're going to build on our discussion of the balance sheet equation to talk about assets, liabilities, and stockholders' equity in more detail. We're going to provide precise definitions for each of them. And we're going to look at situations where we can record them, and situations where we can't record them. Let's get started. Let's start with assets. An asset is a resource that's expected to provide future economic benefits. That means that you're going to generate future cash inflows or it's going to reduce future cash outflows. There are two criteria that we use to decide when to recognize an asset. First, it must be acquired in past transaction or exchange. And second, the value of it's future benefits can be measured with a reasonable degree of precision. So for example, if we a buy a truck, that truck would be considered an asset. We acquired ownership of the truck in an exchange and the value of the benefits of the truck are equal to the price that we paid to buy the truck. So both criteria are satisfied, and it would be an asset. Now we're going to practice applying these criteria to figure out which of the following items would be assets. I'm going to give you a number of items, and for each one, I want you to try to figure out whether it's an asset or not. If it's an asset, try to give me the account name and what the dollar amount would be. If it's not an asset, then try to figure out what criteria would cause it to not be an asset. I'll bring up the pause sign, so if you want to pause and try to answer it yourself, you can, but as always you can just roll through and listen to the answers if you'd like. So let's get started. BOC sells $100,000 of merchandise to a customer that promises to pay cash within 60 days. This will be an asset called accounts receivable. It's an asset because there was a transaction where we delivered goods to a customer and in return we got a promise from them to pay cash. It's an asset because that can turn into cash within the next 60 days. And the value of the future benefits can be recently estimated because it's the amount that customers owes us on the invoice and that amount is $100,000, which is what the value of the asset would be. Next, BOC signs a contract to deliver $100,000 of natural gas to DEF each month for the next year. This one will not be an asset, because there's been no past transaction or exchange. Every exchange of cash, goods or services is going to happen sometime in the future. Nothing has been exchanged yet, so there can't be an asset for it. >> Excuse me, both of these two sound like promises to me. Why is the first an asset but the second is not? >> That's a great question. In the first example, the customers promised to pay us cash but we've acquired that promise through delivering them goods. In other words, there's been a past transaction exchange which is that first criteria for recognizing an asset. In a second case, all we've done is sign a contract. If the contract was broken, it's not clear we'd have any basis to ask the customer to pay us $100,000. And so this first criteria acquired in a past transaction or exchange is there to raise our assurance that something that we want to call an asset is a legitimate resource that should deliver future benefits as opposed to a simple promise that could easily be broken. As might be the case if there's a contract that was signed with no company exchange of cash goods or services. BOC buys $100,000 of chemicals to be used as raw materials. BOC pays in cash at the time of delivery and receives a 2% discount on the purchase price This is an asset and we'll call this asset inventory. Inventory is a term that we're going to use for any product or raw materials that we buy, that we're going to turn into a finished product, that we're going to sell at a markup. It meets both criteria. We acquired the chemicals in a market transaction. And the value of the benefits is known here because it's what we paid in the market transaction. And note that the value here is $98,000 not $100,000 because we value it what we actually paid for it not some kind of higher sticker price that wasn't what the transaction actually happened at. BOC pays $12 million for the annual rent on its office building. It has already occupied it for one month. This is an asset. We're going to call it prepaid rent. It meets the first criteria, because in a market transaction we paid for the right to occupies space in this office building for 12 months. The value the benefits are also known there what we pay for but note that at this point the value the benefits is only 11 million not the 12 million that we've paid. Because we've already occupied it for a month, we've used up one month of the future benefits. So at this point in time, there's only $11 million of future benefits so we have prepaid rent worth $11 million. BOC buys a piece of land for $100,000. Its broker said this was a steal because the land is probably worth $150,000. This is an asset which we'll call land. Meets the first criteria because there is a market transaction where we acquired ownership. The value of the benefits are assumed to be what we paid for it, which is $100,000. Now note, we ignore the last sentence about what the broker thinks the land is worth, because that's not what we paid for in a market transaction. And so we're not going to use that as the value of the benefits, we're going to use the more objective number of we actually paid for it so we've got an asset, land that's worth $100,000. BOC is advised by a marketing firm that its brand name is worth $63 million. This would not be in asset because we never acquired it in a past transaction or exchange. And you could argue that the value of the brand cannot be measured with a reasonable degree of precision so it doesn't really meet either criteria. >> Are you saying that marketing people do not know what they are talking about? >> No, no, no, I definitely respect marketing people. Some of my best friends are marketing professors. It's simply a case where accountants have decided to err on the side of reliability or objectivity. We're not a market transaction where the company has acquired the brand. We can't be sure of how much it's worth. And so we err on the side of leaving it off the financial statements. For this reason you will often see the value of the company in the stock market to be greater than the value on the financial statements because investors would consider this to be an economic asset whereas the accounting system is going to ignore this asset as not reliable enough. Now we're going to turn to liabilities. A liability is a claim on assets by creditors or non-owners that represent an obligation to make future payment of cash, goods, or services. >> My former boss called me a liability to his organization. Is this what he meant? >> No, you were probably a liability in a different sense. Let's go on. Just like assets, there are two criteria for when we recognize a liability. First, the obligation is based on benefits or services received currently or in the past. And second, the amount and timing of payment is reasonably certain. And even though the words are different, these are essentially the same two Criterias for the assets, the first one says there has to be some kind of transaction or exchange, where you've received something that creates an obligation. And the second criteria says you can measure the amount of what the obligation is. So for an example, let's say we borrow money from a bank. We have an obligation to repay the bank based on receiving the benefit of getting the money now. The amount of timing of the payment is reasonably certain, and if there was any question, I'm sure the bank would clarify how much we exactly owe them. So borrowing money from a bank would meet both criteria and it would be a liability called something like notes payable or mortgage payable. We're going to do the same exercise now with liabilities. I'll give you a number of items. I'll give you a chance with the pause sign to try to answer them if you'd like and then we'll talk about what the answer is. First item, BOC receives $300,000 of raw materials from its supplier and promises to pay within 60 days. This'll be a liability. We're going to call this liability accounts payable. We use that term any time we owe money to a supplier. It meets the first criteria because we got the benefit of raw materials in a transaction which now creates the obligation to pay our supplier. And the amount of the obligation is reasonably certain, it's the $300,000 which is on the invoice. So we're going to have an accounts payable liability for $300,000. Based on this quarter's operations, BOC estimates that it owes the IRS $3 million in taxes. This will be a liability. We'll call this liability, income tax payable. So a little bit hard to see the first criteria here, because there was no explicit transaction. But essentially what happened is the government allowed us to operate our business. So we got the benefit of being able to operate our business in this country. And in return, it created an obligation to pay them taxes. Based on the right to operate the business. We have to then estimate the amount of the liability even though we don't know exactly what the taxes are at this point. We can estimate them with reasonable certainty. We come up with $3 million, it's our estimate so we would have a liability called income tax payable for $3 million. >> You said that the amount and timing of payment has to be reasonably certain for there to be a liability. Why is an estimated amount considered to be reasonably certain? >> We're going to have to make a lot of estimates in accounting. As long as we're reasonably certain about the number, we should go ahead and book the liability. For something like taxes, there are tax forms available on the web. We have a rough idea of how much our taxable income will be during the period and so we can estimate what our tax liability is. Now, it may not be 100% correct when we eventually file the form, but whatever our best estimate is, is a much better estimate than ignoring it completely, so we go ahead and put our best estimate on the financial statements. Next, BOC signs a three years, $120 million contract to hire Dakota Dokes as it's new CEO, starting next month. This one is not a liability and it's not a liability because there's no obligation based on benefits that have been received currently or in the past which is the first criteria. Until Dakota actually works for us and works for us without getting paid, they're cannot be a liability. And even then the liability would only be for the time that he or she has worked without pay. We wouldn't book a liability for the entire three year contract because we haven't received the benefits for that yet. Plus there's too much uncertainty with that because Dakota could quit tomorrow, we could fire Dakota, our lawyers, his or her lawyers could find a way out of the contract. There's too much uncertainty over the dollar amount for the three year contract. So we only are going to record a liability for the amount of time that Dakota's worked for us. Since he or she hasn't worked for us yet, there would be no liability. BOC has not yet paid employees who earned salaries of Of $1,000,000 during the most recent pay period. This would be a liability which we're going to call salaries payable. It does meet the first criteria because there's an obligation based on the benefits we've received. The employees have worked for us, we've gotten the benefit of their services. And now we have an obligation to pay them for those services. The amount we owe is reasonably certain. And again if there were any questions the employees would surely let us know how much we owe them. So we have an obligation based on past benefits for $1 million, and we book a liability called salaries payable for $1 million. >> In both of these last two examples, we have not yet paid our employees. Why is this one a liability, but not the previous one? Is it because the first one pertains to an executive, whilst the second one pertains to lowly employees? >> No, no, no, it has nothing to do with status. It simply a matter for a liability to exist, there must be some obligation based on benefit or services received in the past. Employees that have worked for us without being paid, creates a liability for us. Employees that have not yet worked for us, cannot create a liability. BOC borrows $500,000 from a bank on a one-year note with a 10% interest rate. I've talked about this example earlier. This would be a liability called notes payable. Meets the first criteria because we have an obligation based on receiving the benefit of the $500,000 from the bank. The amount that we owe is reasonably certain, it's $500,000, so that meets the second criteria. So we have a liability called notes payable for $500,000. >> What about the interest? We will owe interest on the loan. Shouldn't there be an interest payable as well? >> Great question. Interest is not a liability at this point because we just took out the loan. And we can presumably pay it back right now without owing any interest. Interest only becomes a liability as the money is outstanding over time, and to the extent that we haven't paid it, the amount of interest that we owe, but haven't paid becomes a liability. Finally, BOC is sued by a group of customers who claim their products were defective. The suit claims damages of $6 million. This would not be a liability. It does meet the first criteria. There's a potential obligation based on a benefit received in the past. The benefit was we sold products which turned out to be defective. Doesn't meet the second criteria though, because we can claim that the amount of the payment is still uncertain. Until we have a settlement or we go to trial, we don't know that we have to pay anything. So because of that uncertainty, we don't have to record a liability in this case. Finally, we have stockholders' equity. Stockholders' equity is the residual claim on assets after settling claims of creditors. In other words, it's assets minus liabilities. Lot of synonyms for this, it's also called shareholders' equity, owners' equity, net worth, net assets, net book value. Unlike assets or liabilities, there are not two criteria for how to measure stockholders' equity. Because if you measure all your assets correctly and you measure all your liabilities correctly, that stockholders' equity is whatever's left over. But there are two sources of stockholders' equity. The first source is what we call contributing capital, which arises from selling shares of stock to the public. So we'll talk about common stock and additional paid-in-capital That's what you record when you issue new shares to the public. Common stock is for the par value, additional paid-in-capital is for everything you receive above the par value. And then treasury stock is what we call it when the company repurchases its own stock from investors. >> What, what is this thing called par value? Is this why there are so many accountants on the golf course during the day? >> I'm not sure why you're seeing so many accountants on the golf course, but it has nothing to do with par value. Par value's this archaic, historical concept. There used to be laws which said that companies couldn't issue new equity if the value of their stock was below the par value. Where they couldn't pay dividends value is below the par value. Most of those laws are gone now and par values main implication is that when we issue equity, we put the par value amount of the proceeds into an account called, common stock. You put the rest into additional paid in capital, you'll see this more in subsequent videos. The other source of stockholders' equity is retained earnings which will rise from operating the business. Retained earnings is the accumulation of net income, which is revenues minus expenses less any dividends that have been paid out since the start of the business. So what are dividends? Dividends are distributions of retained earnings to shareholders. They're not considered an expense. And we record them as a reduction of retained earnings on the date the board declares the dividend which is called the declaration date. If we don't pay in cash on the date which is what usually happens, it will create a liability to our shareholders until we actually pay the dividend on the payment day >> Excuse me, please explain that again. Why are dividends not an expense? They are paid in cash like other expenses and why are they a liability? >> Both great questions. First, dividends are not considered an expense because they're not considered a cost of generating revenue. Instead dividends are a discretionary decision by the board of directors to return some funds back to shareholders that's presumably someone independent of the company's performance or sales during the period. Second, we created dividends payable, because once the board declares a dividend, it's essentially holding the shareholder's money, until it sends the check, making the shareholders creditors of the company. Now I admit this one seems weird, because usually liabilities are for non-owners, whereas here we have liabilities for our owners. But we consider them creditors in this one specific case. Best thing at this point is just to memorize it. Dividends are not an expense and when the board declares it doesn't pay a dividend, we can create a dividend-payable liability. And that wraps up our discussion of assets, liabilities and stockholders' equity. Now we have to figure out how to keep track of them. What the good news is in the next video, we'll talked about those magical things called debits and credits, which will help us keep track of everything in the financial statements. See you then. >> See you next video.